The CFPA's Effect on Consumer Credit and A Wager Proposal for Professor Levitin

Professor Adam Levitin is not impressed by our prediction of the effect on consumer credit of the CFPA. Readers might recall that, using estimates from the literature on the effect of regulatory shocks on interest rates and of the long-term debt elasticity, we offered a (in our words) “rough calculation” of the “lower bound” of the effect of the CFPA Act on consumer credit at 2.1%. Professor Levitin says that we just “make up the numbers” and that they do not pass the “straight-faced test.” In his paper (and second blog post) Professor Levitin offers more of the same formula: a combination of assertions unsupported by evidence, ad hominem attacks, and insistence to his prior assumption that the CFPA will reduce the cost of credit without imposing serious regulatory costs (again, without substantiation). He writes that his real problem with our analysis is that “The key point here, however, is the impact of the legislation is speculative and certainly not susceptible to precise statistical predictions.”

We continue to be puzzled as to how a carefully qualified estimate of alower bound could be confused with a precise statistical prediction. Levitin’s response, unfortunately, does not address our lengthy explanation of how the CFPA will increase lender costs and continues to assert without evidence that failures of consumer protection caused the financial crisis.

More importantly, we’re puzzled by the apparent denial by supporters of the CFPA of the need to provide any evidence that its benefits exceed its costs. In his blog post, Professor Levitin notes that he “didn’t set out to prove a positive case in the critique and don’t need to do so to make [his] central point” in critiquing our analysis. That’s fine. But the central point of the discussion ought to be the costs and benefits of the proposed regulation. The burden lies with the proponents of this broad sweeping change in the consumer protection regulatory landscape to present some evidence in favor of their proposals. Professor Levitin further argues that implying a concession from the absence of empirical support in favor of the CFPA as “ridiculous in this context.” Astute readers may perceive a developing theme. Professor Levitin and supporters of the CFPA Act have expressed indifference at best to the notion of providing empirical evidence concerning the potential benefits of the CFPA. Instead, their general strategy has been to nakedly assert, as Professor Levitin does in his analysis, that failures of consumer protection led to the financial crisis and then proceed to offer regulatory proposals under the assumption that they will have benefits and their implementation will occur without cost. For example, Professor Levitin predicts that issues involving inconsistent regulations between the states will be resolved out of court, that states will likely adopt consistent regulations, and that industry will (apparently costlessly) “conform with the strictest level of regulation.” As we discuss in the paper, there is simply no evidence to suggest that failures of consumer protection caused the financial crisis. None. To reiterate, once again, there is absolutely no evidence whatsoever that failures in consumer protection precipitated the current financial downturn.

So to the supporters of the CFPA Act, and particularly Professor Levitin, who has criticized our analysis for providing at least some evidence of the legislation’s costs, where is the evidence – any evidence – that the CFPA Act’s benefits will outweigh its costs? Do you still support the “plain vanilla” provision despite the fact that both a government agency deigning to design financial products and imposing their offering by banks will necessarily involve significant costs? What are the benefits to outweigh those costs? What is the proof of those benefits? Or, even without “plain vanilla,” where is the evidence to suggest any benefits that outweigh the obvious increase in lending costs (and in turn, interest rates) associated with the CFPA’s new regulatory scheme that we lay out in the paper? We’d like to see two things: a coherent economic explanation of these benefits and some demonstration of empirical evidence suggesting they actually will materialize. Can the CFPA’s supporters really think that the CFPA and its new regulatory landscape will not increase costs to lenders and reduce consumer credit? We concede now, as we did in the original paper, that it is quite possible that some of the new proposals could produce benefits. But as we said then, and repeat now, that discussion should be based on a careful analysis of the costs and benefits of the various proposals.

On to the wager proposal foreshadowed in the title to the post.

The CFPA Act’s supporters have fought vigorously for this piece of legislation. Professor Levitin appears quite confident that our analysis represents a “scare statistic” meant to avoid rigorous cost-benefit analysis and to ignore precision. Of course, we find this line of attack ironic in light of the complete absence of empirical evidence in favor of the CFPA Act mustered up by its supporters. More generally, we’d like to offer Professor Levitin the opportunity to prove that he means what he says about our overestimate of the lower bound of the impact of the CFPA Act on consumer credit and about the beneficial effects of the CFPA Act more generally. We are economists. And so we also believe in the power of revealed preferences. We stand by our estimate of the lower bound at 2.1 percent. If Professor Levitin is correct that is a ‘scare statistic’ that we’ve inflated from the true number, we would like to provide an opportunity for Professor Levitin to profit from our misguided approach and to test whether he really believes that the effect on consumer credit will be smaller than that.

We propose the following wager to Professor Levitin:

If the effect on consumer credit is less than 2.1 percent, you win and we lose

If and when the CFPA Act is passed, there will be ample data to test the impact of the CFPA on consumer credit directly. We’re happy to negotiate what methods should be used to calculate the number to both of our satisfaction. We’re also happy to let you name the stakes. But let’s make it interesting. If it’s good enough for Mankiw and Krugman, it’s good enough for us. What do you say?

The Consumer Financial Protection Agency Act (“CFPA Act”), introduced by the U.S. Department of the Treasury in June 2009, proposes sweeping regulation of consumer lending and borrowing. As we showed in “The Effect of the CFPA on Consumer Credit” (hereinafter “Evans and Wright (2009)”):

The CFPA Act creates massive litigation exposure for lenders facing (a) potential lawsuits from state and municipal governments for violating more stringent financial protection regulations that those entities can adopt pursuant to the CFPA Act; and (b) litigation under the CFPA Act’s new and undefined standards for engaging in unfair, deceptive, abusive, or unreasonable practices.

The new Agency would impose significant costs on lenders who would be required to: (a) offer to consumers on a preferred basis plain-vanilla products designed by the Agency either before offering their own products or at the same time; (b) seek prior regulatory approval for new lending products which could be defined as minor variations on existing products; (c) face the risk of having lending products banned altogether; and (d) have to comply with various other rules and regulations.

This note responds to a recent paper by Professor Adam Levitin offered in response to Evans and Wright (2009). As a prefatory matter, his paper is filled with various ad hominem attacks which we will ignore. Instead, we focus on the substance of the issues in contention. Professor Levitin’s basic substantive objection is that he disagrees with our estimates that the Treasury Department’s bill would increase interest rates by at least 160 basis points and reduce net job creation by 4.3 percent under plausible assumptions. Professor Levitin’s criticisms are misguided and we stand by those numbers as lower bounds on the effect of the Treasury’s CFPA Act on the economy. We also note that Professor Levitin has disputed virtually none of our findings that the CFPA Act would impose high costs on lenders and ultimately result in denying borrowers choice.

We think it is impossible to read the CFPA Act without concluding that lenders will face higher costs as a result of, among other things, dealing with the new Agency, being forced to offer products designed by a governmental body rather than themselves, coordinating the sale and distribution of financial products across regulatory regimes varying across the fifty states, and facing the increased possibility of fines and litigation under a novel and ambiguous “abusive” practices standard. While we believe there is a debate to be had on the costs and benefits of the CFPA Act, it is difficult to fathom a claim that this particular Act will not impose significant costs on lenders and that those costs will not be passed on to borrowers. Sound public policy should be based on a careful analysis of the costs and benefits of the various proposals. We do not believe Professor Levitin has made a constructive contribution to that deliberation but encourage him and others to do so as Congress considers the CFPA Act of 2009.

We encourage interested readers to take a look at our papers for themselves:

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